STP: Half a Century of Unfulfilled Promises

Having gone so far with processing efficiency as the lead in the mantra of the STP vision, the industry is now seeking global standardization solutions to STP under the new mantra of mitigating global systemic risk.

STP and synchronized settlementsOh, and one other STP objective we still have left to accomplish: Synchronizing trade and settlement cycles, not only within traded asset classes within markets, but across asset classes and across markets. Cash flows resulting from settlements of one asset class are needed for payment against purchases of other assets classes. When contract markets settle overnight, government-debt markets settle intra-day, and equity markets settle in three days, we have tremendous gaps in cash flows between firms and clearing houses. Systemic risk of significance would occur should one firm not honor its settlement liabilities after receiving others’ settlement obligations.

Successful STP undertakingsMost industries in the physical supply chain have invested in universal product and supply-chain-identification coding schemes to identify their physical products and documents uniquely, and to identify their manifestation in electronic transactions. They have further standardized their identifiers for transportation intermediaries, delivery locations, and counterparties. They began this investment nearly four decades ago when the Universal Product Code was designated and manifested in the ubiquitous bar code (now RFID tags and QR Matrices) seen on all products and posters around the globe. The concepts of scanning items at the check-out, automated inventory replenishment systems, just-in-time delivery systems, and direct store-delivery systems are just some of the STP efficiency benefits made possible by these code standards throughout the physical world’s supply chain.

These standards and tagging systems also help to mitigate operational and systemic risks. Regulators can, for example, track a tainted Tylenol capsule back to its manufacturing process or find the source of tainted beef around the globe. The parallel project of accomplishing the same in the global financial supply chain -- tracing transactions from issuance to order, to trade, to payment, to ownership, to asset-servicing, to risk aggregation -- is obvious and long past due.

In contrast, during the financial crisis financial, regulators could not find the mortgage that was defaulted on in a US city that wound up as a toxic asset on the balance sheet of a failing bank in Australia. Financial regulators could not see the counterparty positions allegedly held by convicted financial con artist Bernard Madoff at a London OTC options dealer. They certainly missed the numerous movements of securities bundled into Lehman’s Repo 105 collateral moving from the US to the UK and back again to dress up their US leverage ratio.

STP and global identification schemesWe as an industry we could not see the forest for the trees. Now governments and their financial regulators around the world are onto the issue like never before. They need standardized data to do their work. They always needed it to oversee that which they had responsibility for regulating, but they didn’t know what to ask for. They need it now as well to analyze systemic risk, the new mantra forcing the issue of data management and straight-through-processing to the fore.

The financial industry needs it as well. We always needed universal, singularly unique identifiers to mitigate operational risk. It is in their interests that regulators are now calling for such capability in order to monitor systemic risk. They want the tools to protect one financial institution from the contagion of another in this interconnected global system. Regulators have discovered what we knew for decades, that the root cause of the problem was the lack of a global identification system for financial market participants and the contracts and instruments they trade in. Regulators are now providing the motivation for the industry to come together, as other industries have, to solve this problem through global collaboration.

STP lesson: Learn from othersThe experience of the physical goods segment of the global economy has direct parallels to the global financial services industry. The development of a universal coding system for products, businesses, transportation intermediaries, locations, and trade counterparties led directly to the efficiencies that made Walmart, FedEx, and Amazon economically efficient commercial businesses. That transaction lifecycle, with that brand of STP, not only moves physical inventory, but also provides for an information audit trail.

The financial industry does not have a physical inventory to move, along with its data. It should be easier to get STP done here if we get our global ID house in order, synchronize our trade and settlement cycles, and add technology infrastructure. “Cooperation before competition” should be another mantra in our quest for STP.

Allan is President and founder of financial industry joint venture development company Financial InterGroup Holdings Ltd; and strategy & acquisition consultancy Financial InterGroup Advisors. The companies are engaged in the capital, contract, currency, cash and investment ... View Full Bio

Notwithstanding the perception of futures trading being far ahead on STP, there are manual steps in the process that is performed over disputed trades that get 'adjudicated' prior to the opening of the next mornings' trading day. Basically through the traders' reconciliation out trade ethos "I'll eat this one today, you owe me the next one". It is also much easier to trade, clear and settle in vertically integrated venues as is the futures industry. Equity markets trade in multilateral venues so more time is required to put the pieces together, reconcile each piece to the other side of the trade, novate and clear each trade, then send it on for depository or custodian trusteeship. Truth be told, in the futures industry that piece, the post trade allocation process of multiple CTA's (Commodity Trading Advisors) transacting through multiple clearing FCMs (Futures Commission Merchants) that advise and execute on a single portfolio is not well automated and is a very important next step for futures markets in order to get to STP. This is the equivalent of multiple investment managers transacting through multiple executing brokers in equity trading. In futures markets, many administrators still have to piece together multiple segments of trades done by multiple CTA's through paper confirmations in order to produce statements and K1s per client.

Now to the ambitious STP effort of 'GSTPA Axion 4'. It was developed by SegaIntersettle- the Swiss Depository; SWIFT- the financial messaging network; and TKS Teknosoft - a Swiss-Indian software development joint venture. The industry raised $100 million from 100 financial institutions globally and issued an RFP. This joint venture won the bid against DTCC and others. It failed because DTCC persisted after they lost, to leverage their existing legacy equivalent although less ambitious trade management system. Initially DTCC faced off against Thomson Financial who too had a less ambitious legacy trade manager activity. Both existed and were operational. So legacy best practices of the past, not a new best practice for tomorrow, won the day. Eventually under threat of patent infringement claimed by Thomson against DTCC, they agreed on a joint venture and named it OMGEO. OMGEO pushed GSTPA Axion 4 aside, even though it was set to create a more real-time matching flow manager as each side of a transaction was prepared and entered into the matching engine as it came available. It showed promise as a mechanism that could evolve into real-time STP and shrink the settlement cycle. Its success required global reference data to be standardized around its own developed standards.

The true test of STP was to come in the Greenfields opportunity presented by regulators to automate the OTC swaps markets. SEFs (swaps execution facilities) aka swaps exchanges was where swaps contracts were to trade in a multilateral environment, forwarding their executed trades to a SDR (swaps data repository) of its chose, and do this in T+1 time. Unfortunately the precursor to this potential, a global identification system for counterparties and contracts, and the reference data associated with each, got off to a rocky start (to be kind to the dysfunction that is now apparent to everyone). It is currently stalled in regulatory indecision. Industry practitioner comments have been requested publically by the CFTC and by the global standards body, the Financial Stability Board. The industry needs to help regulators, first not to miss this opportunity, and second to show that STP is possible in this new market, having learned our lessons of past missteps based on legacy thinking. Cooperation before competition is necessary.

STP requires globally unique identification of financial market participants, of the contracts and instruments they trade in and the financial events (mergers, acquisitions, et al) that change both. All these have a source or origin, the financial market participant itself- as counterparty, as issuer, as originator of a corporate change of control. Financial market intermediaries, whether data vendors, market infrastructure utilities, or financial institutions that interject themselves in this flow add risk to the system, additional infrastructure costs, and basically imped the realization of STP.

With a global identification system and standard reference data and data tags in place we can realize the vision of STP, no sooner and no other way. T+2, even T+1 should be intermediate goals to ready the industry on the way to a real-time order-trade-clear-settle-pay mechanism across all asset classes. The design of this solution cannot be accommodated in single markets, or by single market infrastructure utilities, a global design needs to be drafted, geared to attain real-time STP. Only when we know how we are to attain the final real-time STP solution does intermediate solutions like T+1 and T+2 make sense. The good news is we have a global regulatory standards initiative underway – we just have to make some needed adjustments, significant ones I might add, and we have the pillars upon which to build a final STP solution. Visionary industry leadership is required.

Allan, first I want to thank you for writing this amazing, comprehensive history of STP that spans decades, numerous asset classes, standards initiatives and presents a vision of where STP must go.

One initiative you didn't mention was the Global Straight Through Processing Association - late 1990s- comprised of leading buy side, sell side firms and Omgeo, if i'm not mistake. It was focused on automated trade matching. I'm not sure what the group accomplished but it ultimately fizzled out.

Regulators are now driving the urgency of STP to prevent systemic risk. DTCC is now urging the industry shorten the settlement cycle to T+2. You also talk about the need for synching the settlement cycles across different asset classes. Are you in favor of T+2? How hard will it be to get there? And why not go straight to T+1 like futures?

First, there were only two studies that I know of that made estimates of the value of STP to the 'industry'. Tower Groups Global STP Study in 2001 pegged the lack of STP at $12 billion. A STP related SIA/Capco/Accenture study on T+1 in 2000 concluded that T+1 would result in annual cost savings of about $2.7 billion—and would cost the industry $8 billion to achieve, a three-year payback at the industry level. This later study also identified Reference Data as the second most costly inhibitor of STP. Our study done on 2004 data and updated in 2012 pegged the duplicate annual costs of reference data alone amongst the largest financial institutions on average at $ 1,318 - $ 2,322 billion. There are now some 49 SIFIs identified to date, those being the largest and most interconnected global financial institutions that could be the significant benefactors of STP savings. That would put the industries duplicate spend just on reference data at $50+ billion.

Second, there is now regulatory compulsion at the root level for STP. It is driven by the need to aggregate data for systemic risk analysis.It is a G20 inspired global identification system for financial market participants and the products they trade. If the global commercial supply chain can have its equivalent of STP based upon a global ID system (the codes populating the ubiquitous bar code, RFID and QR matrices) we should be quick to leverage this effort and move to reengineer our financial institutions. Tech savvy companies like Walmart, Amazon and Fed Ex have gained significant STP efficiencies.

In the final analysis the greatest inhibitor to STP is the business silo mindset that inhabits the large financial institutions. Enterprise-wide initiatives of this magnitude can only be the province of the CEO as that is where it all these separateexpense budgets comes together. It would be a waste of billions if the industry would have to wait for another generation of CEO, one that comes from the technology savvy world, to tackle the STP problem.